Indian banks have the highest compounded annual growth rate of profits in the world. They reported a CAGR of 39 per cent between 1996 and 2001, compared with the global average of 18 per cent. The CAGR of Asian banks fell 1 per cent during the same period.

However, Indian banks failed to score on profitability per customer, management consultancy firm McKinsey & Company Director Tab Bowers said in an exclusive interview to Business Standard.

Bowers is one of the three authors of a recent McKinsey report that points out that the profitability of Indian banks in terms of the return on capital and the profitability of core banking operations are not adequate.

The winning strategies outlined by McKinsey in its study "Banking in Asia: Acquiring a profit mindset" points to the need for clear customer segmentation and product offerings, focus on cost efficiencies and entrepreneurial ability to face stiff competition.

Describing India as a market of extremes, the report says India is a target market because it offers significant growth opportunities. It points out that Citibank and Standard Chartered Bank account for more than half of the outstanding credit card receivables and personal loans in the Indian banking sector. "This possibly translates into an annual profit of about $30-50 million each," the report says.

Consolidation has not taken off in India, but will be triggered by capital scarcity. This is unlike the Asian scenario where 51 per cent of the top 500 banks disappeared in four years after the financial crisis in East Asia.

The majority of these banks went off the scene after they were merged or acquired by others. Quite a few banks closed shop on account of bankruptcy, the report added.

Bowers pointed out that the return on capital of Indian banks was low because they failed to attract profitable businesses. "Seventy to 80 per cent of the corporate accounts and retail customers do not make money for banks. Banks tend to concentrate on just the spreads without identifying the cost on a risk-adjusted basis as far as the corporate customer is concerned. At the same time, they fail to see the cost of servicing retail clients as they try to push banking-related products to all segments of customers," he added.

The case is similar in most Asian countries. "Leading global banks are pushing financial services to individuals in Asia, but most are struggling to earn sustainable profits.

Multinational institutions have grabbed small market shares, which are yet to contribute significant profits to their global parents," the report says.

"Banks have found attractive retail banking opportunities in India, but a huge portion of their operations are unprofitable for want of a cutting edge over competition. This puts a strain on the capital base," said Bowers.

The current report, which is a sequel to McKinsey's earlier study "Banking in Asia: The end of entitlement", talks of the immense opportunities in the Asian banking sector and how these riches came with risks and volatility.

Bowers has also cautioned banks against adopting the universal banking model because they may lose out on per customer profitability in trying to be everything for every customer. Banks should focus on their core competence rather than opting for the universal banking model, he said.

The report pointed out that while the old guard private sector and the state-owned banks accounted for over 80 per cent of the total banking assets in India, their combined profitability was a paltry 0.4 per cent in terms of the return on assets.

"One will make profits in India on the back of the growth in banking assets, but the point is what is the return on capital, which drives market valuations," McKinsey Principal Joydeep Sengupta added.